Equity gains expected to hinge on economy

Economic indicators may need to change for the better by October in order for U.S. stocks to sustain this year’s gains, according to Myles Zyblock, chief institutional strategist at RBC Capital Markets.

As the chart below shows, shares of companies most affected by the pace of economic growth have been out of favor for months. The chart tracks the ratio of Morgan Stanley indexes for cyclical and consumer-product shares since March 2009, when a bull market in stocks began.

“We see one of two likely scenarios” unfolding for stocks, Zyblock wrote two days ago in a report. The first is that the economic gauges will rebound during the next month or two to confirm the gains in stocks. The second is that share prices will decline as the indicators fall further.

The cyclical-consumer ratio, cited in the Toronto-based strategist’s report, rose only 0.2 percent for the year through yesterday as the Standard & Poor’s 500 Index gained 12 percent. The contrast became more pronounced in the past two months as the S&P 500 rebounded from its second-quarter low.

Rather than tracking the S&P 500, the cyclical-consumer ratio tended to move in lockstep with the Institute for Supply Management’s factory index, as the report showed. ISM readings for June and July were less than 50, pointing to a contraction in manufacturing.

Based on the backdrop, Zyblock wrote, higher stock prices can be attributed to “fast money investors who’ve been caught short, corporations with excess cash, and international equity investors running away from their home markets.”

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